Accounting: Moved to tiers by the changing face of UK reporting

A radical upheaval in the UK’s corporate reporting landscape
is on the cards. Proposals from the Accounting Standards Board look set to align
our accounting regime with international accounting formats. Such a move would
effectively consign UK generally accepted accounting principles to history.

These ideas have threatened from backstage for a couple of years now. But
recent moves by the International Accounting Standards Board means they can move
from proposals to reality. The catalyst was the publication of the IASB’s
International Financial Reporting Standard for small and medium-sized entities.
The impact is likely to be most keenly felt by medium-sized companies and most
subsidiaries of large corporates ­ but there could be some losers.

The new regime is three-tiered and the key to where a company sits within the
regime is its public accountability. At its simplest, tier 1 is for listed and
other publicly accountable companies; tier 2 is for all big and medium-sized
outfits that aren’t publicly accountable; and tier 3 for small companies that
prepare accounts using the UK FRSSE (financial reporting standard for smaller
entities).

Advantages claimed, and largely accepted, for the three IASB-led tiers is
that reporting will be simplified by being targeted and appropriate (the ASB
uses the term ‘proportionate’). Moving to IASB-based standards will provide a
consistency which should benefit users’ understanding, help all those involved
in preparing accounts and ease the route to accessing capital markets. While
companies will have to produce accounts commensurate with their tier, they also
have the right to produce accounts based on a higher tier ­ for example, if they
plan to become publicly-listed.

First introduced in the UK seven years ago, FRSSE is now well understood. In
contrast, the recently published IFRS for SMEs is an unfamiliar beast. If FRSSE
is IFRS-junior aiming to simplify accounting standards, then IFRS for SMEs is
IFRS-lite (still following me?). Accounts are prepared using the same
principles, but without many of the additional disclosure burdens aimed at the
largest businesses, omitting the need to report earnings per share, avoiding
segmental reporting and the requirement to amortise goodwill. Somewhat
worringly, though, accountants at PricewaterhouseCoopers believe the disclosure
requirement will be 80% less than under full IFRS. This tempting prize would
prove most useful for thousands of subsidiaries of quoted companies. The
present, strange situation is that, while listed companies report in IFRS, most
of their UK-based subsidiaries have stayed with UK GAAP.

Implementation by 2012 will require work by finance directors as soon as the
ASB reaches its decision, sometime next year. The key issue which may prove a
stumbling block for the proposed regime is the accountability test. The ASB’s
proposals envisage that the differential reporting regime is based on a
definition of public accountability, broadly in line with the IASB definition.
Standard setters believe all companies whose equity and debt are traded on
exchange have a duty to the public to report at the top tier regardless of size.
But some argue that, even if the nature of the business implies public
accountability, size cannot be completely ignored ­ examples being UK building
or friendly societies. In the other quadrant beloved of management consultants,
are large private companies automatically publicly accountable? For instance, a
business may have an environmental impact that renders them publicly
accountable: is that best dealt with by extensive financial disclosures?

The issue for FDs in large corporates is the status of wholly-owned publicly
accountable subsidiaries ­ for instance, the legal entity that issues debt. The
ASB thought long and hard about whether wholly-owned subsidiaries should get
some form of disclosure exemption, provided the disclosure happens elsewhere in
the group. In the end, it couldn’t see any benefit in setting up a modified
disclosure regime for that niche category. So unless they face a storm of
protest, FDs of large groups are going to have to carve up their subsidiaries
into publicly and non-publicly accountable groups.

This is a tricky area for both standard setting and law. At the end of the
day, the question of public accountability depends on how you see the world.
Would you rather err on the side of caution and include more companies in tier
1, even though the reporting requirement would be a nightmare for an unlucky
few? Or, would you rather narrow the definition and run the risk that some
companies, which users of accounts may see as publicly accountable, may slip
through the definition net and therefore not have to fully disclose? Given the
current uneasy climate post-credit crunch, the smart money is surely on casting
the net wide so no potentially embarrassing minnows escape.

If the ASB and the government can solve that little conundrum, they should
have a UK reporting regime fit for a globalised economy. Even if that means
consigning UK GAAP to the dustbin with little regret.